Keeping up with discussions about economic trends, such as a recession, can sometimes cause whiplash and confusion. Experts are always keeping an eye on the economy, markets and other factors to try and predict the next big market move, and the word “recession” in particular, can cause anxieties to rise.
Knowing the causes and predictors of recessions can help you better prepare for any time the economy takes a turn in that direction.
What is a recession?
In technical terms, a recession is a contraction or significant decline in the economy that lasts for more than a few months. It’s often defined as two consecutive quarters of negative real Gross Domestic Product (GDP) growth.
Causes and predictors of recessions
Economists need several months of data to determine a true recession, so they often aren’t officially declared until multiple months into a downturn. Still, knowing these key signals can help you prepare.
Economists need several months of data to determine a true recession, so they often aren’t officially declared until multiple months into a downturn.
Main causes
What can trigger a recession? A few things:
Economic shocks: Events like a spike in oil prices can reduce the economy’s capacity to produce goods and services.
High interest rates: When interest rates increase to fight inflation, the cost of borrowing increases, which can slow down consumer spending and business investment.
Pandemic impacts: External disruptions like a pandemic can interrupt supply chains, increase production costs and reduce the economy’s ability to produce goods.
Decreased consumer confidence: Widespread fear and uncertainty can cause consumers to cut back on spending.
Indicators to watch
These can signal a recession in the months and years leading up to it:
Inverted yield curve: When short-term Treasury bonds (such as the 3-month or 2-year) offer higher interest rates than longer-term Treasury bonds (like the 10-year bond), it can be an indication that the market is expecting an economic slowdown.
Rising unemployment rate: If an increasing number of businesses are forced to close their doors or lay off employees to stay afloat, this can lead to fewer employment opportunities and increased financial strain on workers.
Decline in GDP: A drop in GDP can be a signal of significant slowdown in economic activity.
Decreased consumer spending: When people spend less than they normally do across the board, the economy feels it.
How to prepare for a recession
While an economic downturn can lead to anxiety and uncertainty, taking steps to prepare can improve your financial stability and outlook:
Build an emergency fund: Aim to save at least three to six months’ worth of essential living expenses. You can use an Ally Bank Savings Account as a safe place to store and build your emergency fund, while earning interest.
Evaluate your debt-to-income ratio: Explore different strategies to pay off debt to reduce the percentage of your earnings that go toward debt repayment.
Review and adjust your budget: Prioritize essential expenses and look for ways to cut unnecessary spending.
Invest wisely: Reduce risk by diversifying your portfolio and investing in a mix of different asset classes, such as stocks, bonds and real estate.
Enhance your skills and career prospects: Since recessions can result in an increase in unemployment, explore opportunities for professional development to boost your skills and increase your value in the job market.
Navigating through a recession confidently
You don’t have to wait for an official recession declaration to get an idea of the state of the economy. By keeping a pulse on the state of the economy and working toward building or strengthening your financial stability, you can make more informed spending and saving decisions regardless of what the future holds.
